EU summit divisions reignite euro jitters

Franco-German competitiveness proposals meet stiff opposition

By

WilliamL. Watts

LONDON (MarketWatch) — German Chancellor Angela Merkel has some serious cajoling to do after fellow European leaders gave a plan for boosting the competitiveness of the euro zone’s weakest economies a cool reception last week.

At a summit meeting of 27 European Union leaders in Brussels on Friday, Merkel and French President Nicolas Sarkozy presented a proposal for a competitiveness pact that would revamp the euro zone’s rescue fund for debt-strapped countries while imposing tougher budget rules and more coordination of fiscal policy across the euro zone.

News reports described the debate over the proposals as heated. In the end, leaders agreed to further discuss the matter further next month, adding a leaders meeting in early March.

Violent anti-Berlusconi protest

(1:09)

A weekend of protests against Italian Prime Minister Silvio Berlusconi culminated in violent scuffles between demonstrators and police outside the premier's villa in Milan.

“Friday’s tetchy debate exposed once again some of the fractious issues that continue to bedevil the single currency,” said Michael Derks, chief strategist at FxPro.

“For example, all of Europe’s leaders agree on the principle of greater economic and fiscal policy coordination, but as soon as there is any specific binding proposal on tax or debt or spending, this concord rapidly disintegrates,” he said.

Leaders had already planned a late March meeting aimed at cementing a proposal to shore up the rescue fund in an effort to ease the region’s long-running debt crisis.

“After all the excitement, last Friday’s EU summit disappointed even our modest expectations with a mere promise to adopt a comprehensive package at the March 24-25 summit,” said Michala Marcussen, European economist at Societe Generale.

But Laurence Boone, economist at Barclays Capital, said the results were as to be expected.

“Although all countries endorsed the communiqué and agreed on the necessity of drawing a common economic framework, debates on the details of the framework are likely to take place as the pact touches all areas of national sovereignty,” Boone said, in a note to clients.

Financial fallout

Disappointment in the outcome of the summit pushed up peripheral sovereign bond yields, analysts said, boosting the premium investors demand to hold peripheral bonds over their German counterparts. The spreads had narrowed sharply ahead of the summit last week.

The cost of protecting peripheral euro-zone sovereign debt against non-payment jumped as well.

The pact marks the effort to strike what has been dubbed a “grand bargain,” which would see Germany agree to expanding the lending capacity and the flexibility of the euro-zone rescue fund, known as the European Financial Stability Facility.

In order to soothe German concerns about footing a large chunk of the bill for future bailouts, euro-zone nations would have to follow Berlin’s lead in enshrining a type of debt limit known as a “debt brake” in national constitutions, while some countries would be required to further raise retirement ages.

The pact would also end the practice of linking salary increases to inflation — a common practice in some European nations. It also aims to harmonize corporate tax rates, taking aim at ultra-low rates in Ireland and the Slovak Republic.

“What we want to establish is a pact for competitiveness and in so doing we want to make it very clear that we intend to grow together more closely at a political level, which is not to say that there should not be a competition for the best solution among the member states,” Merkel told journalists on Friday.

In the end, however, Germany and France hold the trump card, said Marcussen.

“Holding the purse strings offers advantage, and if the other member states want a bigger and more flexible EFSF, they will have to sign up for more German diet,” Marcussen said.

The “debt brake” proposal tops Germany’s priorities, Marcussen said. The German government in 2009 locked in a provision limiting the cyclically adjusted deficit to just 0.35% of gross domestic product by 2016 and setting balanced budgets for the German states by 2020. France has said it plans to follow suit with its own budget rule.

The call to harmonize corporate tax rates, meanwhile, appears to be a victory for France, which has long criticized low rates elsewhere.

The European Financial Stability Facility is the EU’s contribution to the joint €750 billion EU-International Monetary Fund backstop put in place after Greece was forced to seek a bailout last spring. Lending under the facility, however, is currently limited to around €250 billion due to guarantees required to ensure that it maintains a AAA rating.

Germany has signaled it would back changes that would bring the lending capacity of the facility to its full €440 billion. A higher lending capacity would help ease worries the backstop isn’t big enough should debt worries push more countries, particularly Spain, out of the credit markets. Ireland tapped the rescue fund last fall.

Societe Generale expects the pact to ultimately result in a lower cost of borrowing from the European Financial Stability Facility. It’s also likely to be made capable of lending to governments for bond buybacks, but only under strict conditions, Marcussen said.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.